While events over the weekend have had a dramatic impact on the political landscape of Europe, that's just what they are: political events. Yet for all the rhetoric, promises, and bluster, only one thing matters in the end: cold, hard math. The same math which last weekend [9]indicated that Europe is still facing trillions and trillions in bank deleveraging. That has not changed one cents between then and now, regardless who is the puppet (muppet?) head of this country or that. But since that won't become evident for at least a few more years, it can be safely forgotten, until the time comes to recall it that is, at which point there will be a full blown crisis even though there were years of advance warning to prepare for the crunch. So here is some more math: in a downside case forecast looking at funding capacity of Spanish and Italian banks - the same banks that would have been long insolvent had it not been for a $1.3 trillion injection by the ECB - Deutsche Bank predicts that the two groups may have as vast a funding shortfall as €210 billion in 2012 (€114.4 billion in Spain, €96.1 billion in Italy). Which to DB means one thing of course: more LTROs coming because once the market has habituated to the now periodic infusion of monetary heroin it will not let go until it is convulsing in its death rattle, something the status quo will never allow, or until it gets just one more hit.
The math from DB:
[10]
We present in Figure 14 an illustrative scenario for the funding capacity of banks in 2012 in Italy and Spain. We consider there, as we are looking into a “worst case scenario”, that bank debt issuance stops entirely... In the base case, non-residents simply stop rolling their exposure to the ailing sovereigns as bonds are redeemed. In a adverse scenario, they maintain an aggressive pace of outright selling, replicating the pattern of 1Q 2012. We assume that domestic banks “take the slack”.
The “adjustment valve” in this configuration is lending to the non financial sector. In the Spanish case, the “shortfall” between the cash position as of the end of March and the various explicit or implicit commitments, at EUR 36.3bn, would actually allow for a slightly lesser pace of deleveraging in the private sector than in Q1. Note that in Spain, the “credit impulse”, which measures the yoy change in net flows of loans to the non financial private sector, is already almost neutral. In the adverse scenario, Spanish banks would have to nearly double the pace at which they cut lending to households and businesses in 1Q 2012. In the Italian case, the current pace of deleveraging would not be fast enough, in our estimate, to cover the various commitments, even in the baseline scenario where non-residents simply stop rolling over.
The agenda to Europe's biggest bank is obvious - scapegoat others, even if with real numbers, to reap the benefits of another reliquification:
This supply/demand approach to the relationship between the banks, the sovereigns and the private sector, explain why we think that, if debt issuance by banks entirely close down, another round of LTROs should be contemplated by the ECB.
The caveat:
Naturally, it is wrong to consider that, short of additional LTROs, banks cannot access central bank liquidity since they can still use the MROs. However, a massive use of these short-term sources of liquidity would probably create an additional duration mismatch on the banks’ balance sheet, not necessarily conducive to significant credit origination.
What would be the efficiency of such a move? A clear limit of this view is that more liquidity injection by the central bank helps the supply of credit, when the latest BLS suggested that demand was actually very depressed, which means that the central bank would, again, be “pushing on a string”.
So the Spanish and Italian strawman is now set: if no LTRO 3, then pain comes back, forcing the appropriate political parties even deeper into a corner.
More importantly, the injection of yet another several hundred billions in "sterilized" liquidity allows the status quo to preserve its ever more tenuous grasp of power for a few more months. Then it will be the Fed's turn, and so on, and so on, until the final additional electronic USD/EUR/JPY has no incremental benefit at all.